Capital Budgeting

Learning Objective
Tools of Investment Decisions(Capital Budgeting)
i. Nature, Feature and Importance of Capital budgeting
ii. Investment evaluation criteria
iii. Discounted Cash Flow (NPV, IRR, PI)
iv. Non discounted Cash Flow (PB and DPB and ARR)

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Tools of Investment Decisions
(Capital Budgeting)
Capital Budgeting
 Capital budgeting is the process a business undertakes to evaluate potential major projects or
investments. Construction of a new plant or a big investment in an outside venture are
examples of projects that would require capital budgeting before they are approved or
rejected.
 As part of capital budgeting, a company might assess a prospective project's lifetime cash
inflows and outflows to determine whether the potential returns that would be generated
meet a sufficient target benchmark. The capital budgeting process is also known as
investment appraisal

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Methods of CB
Traditional Discounted
methods Methods
Discounted
Payback
payback
period
period (year)

Accounting Net Present

rate of return Value (Rs)

Internal rate
of return (%)

Profitability
Index (ratio)

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Modern or discounted methods
1. Discounted payback period
2. Net present value
3. Internal rate of return
4. Profitability Index

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Modern or discounted methods
Discounted Payback period:
It refers to the period in which the proposed project generates enough cash so that the initial investment
is recovered. The project with the shorter payback period is selected.

Net Present Value:

the difference between the cost of a project and the cash flow, if the present value of inflows is more than
the outflow, then the project is accepted or otherwise rejected.

Internal Rate of return

Profitability Index:
Also known as the profit investment ratio or value investment ratio, the profitability index method of
capital budgeting works by examining the relationship between the costs of pursuing a project and its
anticipated benefits

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Discounted Payback period

DPB= Cash outlay(investment)/ Annual Cashflow

Net Present Value

NPV= Present value of cash inflows- Present value of cash outflows

Internal Rate of Return

𝑛
𝐶𝐹 𝑡
𝑁𝑃𝑉 = ∑ 𝑡
𝑡 =0 ( 1 +𝑟 )
Profitability Index

PI= Present value of cash inflows/ Present value of cash outflows

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

Cash outflow format
Particular Amt
Fixed capital
Net working capital

Machinery
(-) Govt Sub
Total cash outflow xxx

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

 Cash Inflow Format
Particular Year 1 Year 2
Sales (in units) sales
(x) Selling price

(-) Operating Expenses (VC+FC)

EBDIT
(-) Depreciation
Operating income before interest and tax/EBIT

(-) Interest paid

Operating income before tax/EBT Xxx taxable income
(-) Tax
Operating income after tax/EAT

(+) Depreciation
CFAT/ After –tax operating income
Book salvage value
08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI
 ABC Ltd has provided you the following information:

Purchase price of New Machinery Rs 4,50,000

Installation expenses Rs 1,50,000
Working capital required 2,00,000

Use life life of machine 5 years

Cost of capital 10%
CFAT
1st year 2,00,000
2nd year 4,00,000
3rd Year 5,00,000
4th year 5,00,000
5th Year 5,00,000

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI

 ABC Ltd has provided you the following information:
Cash outflow
Purchase price of New Machinery Rs 4,50,000
Installation expenses Rs 1,50,000
Working capital required 2,00,000

Present value of cash outflow 8,00,000

08/30/2023 FINANCIAL MANAGEMENT- PROF. MANISHA SANGHVI